What Is the Taylor Rule, and Does the Fed Follow It?

The Taylor rule is a formula that turns two numbers, inflation and the output gap, into a suggested level for the Fed Funds Rate. The output gap is how far the economy's production sits above or below the level it can sustain. The Fed Funds Rate is the overnight interest rate that the US central bank, the Federal Reserve (the Fed), steers. John Taylor, an economist at Stanford University, published the formula in 1993.

Does the Fed follow it? From 1960 Q1 to 2026 Q2, the actual rate was within 2 percentage points of Taylor's 1993 formula in 51.9% of the 266 quarters. The actual rate averaged below the formula in five of the seven periods studied.

Taylor wrote the rule in his 1993 paper as:

r = p + .5y + .5(p − 2) + 2

Each letter has a plain meaning, taken from the paper.

With inflation at 2% and output at its target, the rule gives 2 + 0 + 0 + 2 = 4%.

Inflation appears twice. The first p keeps the rate in step with inflation. The term .5(p − 2) adds half a point for every point above the target. A 1 point rise in inflation therefore lifts the suggested rate by 1.5 points.

Here is a worked case. With inflation at 3% and an output gap of +1%, the rule gives 3 + 0.5 × 1 + 0.5 × (3 − 2) + 2 = 6.0%. A neutral rate of 3 instead of 2 would add 1.0.

Taylor presented the rule in "Discretion versus Policy Rules in Practice", in the Carnegie-Rochester Conference Series on Public Policy in 1993. He introduced it as a rule that "captures the spirit of the recent research" on policy rules.

The paper compared the rule with the actual rate from 1987 to 1992. Taylor wrote that "this rule fits the actual policy performance during the last few years remarkably well". The same paper says that "operating monetary policy by mechanically following a policy rule like equation 1 is not practical".

Later versions differ. In 1999 Taylor analysed a rule with a weight of 1.0 on the output gap instead of 0.5. The Federal Reserve Board calls that form the balanced-approach rule.

Who sets the rate is covered in who votes on interest rates. The mechanics are in how the Fed sets rates.

The rule needs three choices: an inflation measure, a gap measure and a neutral rate.

Taylor's paper measured inflation with the GDP deflator, the price index for everything the US economy produces. The Fed's 2% objective is defined on a different measure, the Personal Consumption Expenditures (PCE) Price Index, which tracks what households buy. See PCE inflation.

For the output gap, this article uses the Congressional Budget Office (CBO) estimate of potential output, the level the economy can sustain.

One test uses an unemployment gap instead. It is the CBO estimate of the natural rate of unemployment, the rate consistent with stable inflation, minus the measured Unemployment Rate. The Fed's explainer notes that 1 point of output gap corresponds to about 0.5 point of unemployment gap, so that version carries a weight of 1.

This article tests five versions.

Version 1 is the rule as published, with Taylor's coefficients and inflation measure. The first two charts use it. All five use a neutral rate of 2 and a target of 2.

The data are today's estimates. GDP and potential output are revised over time, so the Committee saw different numbers at the time. The latest quarter, 2026 Q2, may also be revised.

The chart shows the actual rate in blue and version 1, Taylor's 1993 rule, in orange. Both peaked around 1981, the rule at 16.0% in 1981 Q1 and the actual rate at 17.8% in 1981 Q2.

Over the 266 quarters the two lines have a correlation of 0.69. A correlation of 1.0 would mean they always move together. The actual rate sat below the rule in 64.7% of the quarters.

The match is closer in some periods. In 1987 Q1 to 1992 Q4, the window of Taylor's paper, the actual rate was within 2 points of version 1 in 87.5% of the 24 quarters.

The difference can be large. In 2022 Q2 version 1 gave 13.0%, against an actual rate of 0.8%. The rule was negative in only 5 quarters, the first in 2009 Q2 and the last in 2020 Q2. The actual rate stayed above zero.

The second chart averages the difference, the actual rate minus the rule, by decade. A negative bar means the actual rate sat below the rule on average. The average was negative in five of the seven periods.

The 1970s sit 3.6 points below the rule and the 1980s 2.6 points above it. The period from 2020 to 2026 Q2 sits 3.9 points below.

The shaded band spans the lowest and highest of the five versions in each quarter. On average the band is 1.9 points wide (median 1.6). It reached 5.3 points in 2010 Q1. The actual rate lay inside the band in 21.1% of quarters, below it in 51.1% and above it in 27.8%.

The actual real rate, the Fed Funds Rate minus GDP deflator inflation, averaged 1.5% over the sample. A neutral rate of 1 instead of 2 lowers the rule by 1 point in every quarter.

The mean difference then moves from −1.1 to −0.1 points, while the share within 2 points rises from 51.9% to 60.2%. The correlation stays at 0.69, because a constant shifts the level only.

The data show how far the actual rate sat from the rule. They cannot show why. The Federal Reserve Board's explainer says the Committee regularly consults the prescriptions of several policy rules along with other information. It adds that there are important limitations that argue against mechanically following any rule.

The measured record is mixed. The actual rate was within 2 points of the 1993 formula in 51.9% of quarters from 1960 Q1 to 2026 Q2. The average difference by period ran from 3.9 points below the rule to 2.6 points above it.

The Taylor rule formula, as John Taylor published it in 1993, is r = p + .5y + .5(p − 2) + 2. Here r is the suggested Fed Funds Rate, p is inflation over the previous four quarters, while y is the % gap between real output and its target. The rule gives 4% when inflation is 2% and the output gap is zero.

John Taylor, an economist at Stanford University, created the Taylor rule. He published it in 1993 in the paper "Discretion versus Policy Rules in Practice". He later analysed a version with a weight of 1.0 on the output gap, which the Federal Reserve Board calls the balanced-approach rule.

The Federal Reserve Board says the Committee regularly consults the prescriptions of several policy rules along with other information. The same explainer says there are important limitations that argue against mechanically following any rule. The how the Fed sets rates guide covers the process.

The Taylor rule gives different answers because its inputs are choices. The inflation measure, the gap measure and the neutral rate can each differ. Across 266 quarters, the highest and lowest of five versions differed by 1.9 percentage points on average. A neutral rate of 3 instead of 2 adds 1.0 point.

This explainer is part of the YX Insights Academy. Each one takes a single idea and checks it against real data.

The same approach runs through everything else we publish:

Good places to start on the website:

DISCLAIMER: This article is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.